Risk Management

A Rembor & Partners White Paper

REMBOR & PARTNERS 2010 Authored by: eugene.rembor

industrial processes. actuarial societies. the National Institute of Science and Technology. security. Several risk management standards have been developed including the Project Management Institute. assessment. financial portfolios. credit risk. Risks can come from uncertainty in financial markets. and ISO standards. definitions and goals vary widely according to whether the risk management method is in the context of project management. legal liabilities. and prioritization of risks followed by coordinated and economical application of resources to minimize. accidents. and accepting some or all of the consequences of a particular risk.[1] Risk Management | 4/8/2010 1 .Risk Management A Rembor & Partners White Paper Risk is defined in ISO 31000 as the effect of uncertainty on objectives (whether positive or negative). or public health and safety. natural causes and disasters as well as deliberate attacks from an adversary. reducing the negative effect of the risk. avoiding the risk. engineering. project failures. and control the probability and/or impact of unfortunate events[1] or to maximize the realization of opportunities. Risk management can therefore be considered the identification. Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk even though the confidence in estimates and decisions increase. The strategies to manage risk include transferring the risk to another party. monitor.[2][3] Methods. actuarial assessments.

Contents 1 Introduction 1.2 Risk reduction 2.4 Risk retention 2.2 Identification 2.4. Relationship risk appears when ineffective collaboration occurs. a prioritization process is followed whereby the risks with the greatest loss and the greatest probability of occurring are handled first. and balancing between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled. For example.1 Hazard Prevention 2.5 Create a risk management plan 2.1 Establishing the context 2.4. a knowledge risk materializes. "Risk management.4. Vocabulary. when deficient knowledge is applied to a situation.4.1 Method 1.1.2 Principles of risk management 2 Process 2. These risks directly reduce the productivity 2 Risk Management | 4/8/2010 .1 Bow tie diagrams 6.2 Seven cardinal rules for the practice of risk communication 8 References Introduction This section provides an introduction to the principles of risk management.1 Risk avoidance 2."[2] In ideal risk management.3 Risk management techniques in petroleum and natural gas 5 Risk management and business continuity 6 Risk communication 6.4 Potential risk treatments 2. In practice the process can be very difficult. The vocabulary of risk management is defined in ISO Guide 73.2 Risk management activities as applied to project management 4.3 Risk sharing 2.7 Review and evaluation of the plan 3 Limitations 4 Areas of risk management 4. Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability.6 Implementation 2.1 Enterprise risk management 4.4. Process-engagement risk may be an issue when ineffective operational procedures are applied. and risks with lower probability of occurrence and lower loss are handled in descending order.3 Assessment 2.

performed. Resources spent on risk management could have been spent on more profitable activities. and assess threats 2. decrease cost effectiveness. 1.e. be an integral part of organizational processes. take into account human factors. This is the idea of opportunity cost. assess the vulnerability of critical assets to specific threats 3. be dynamic. ideal risk management minimizes spending and minimizes the negative effects of risks. profitability. prioritize risk reduction measures based on a strategy Principles of risk management The International Organization for Standardization identifies the following principles of risk management:[4] Risk management should: • • • • • • • • • • • Risk Management | 4/8/2010 create value. the expected consequences of specific types of attacks on specific assets) 4. Again. identify ways to reduce those risks 5. and earnings quality. explicitly address uncertainty. brand value. identify."[3] the process of risk management consists of several steps as follows: 3 . be systematic and structured. service. Risk management also faces difficulties allocating resources. Method For the most part. characterize. these methods consist of the following elements. more or less. iterative and responsive to change. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity. be part of decision making. be based on the best available information. be tailored. determine the risk (i. be capable of continual improvement and enhancement. be transparent and inclusive.of knowledge workers. Process According to the standard ISO 31000 "Risk management -. quality.Principles and guidelines on implementation. in the following order. reputation.

cause problems. the next step in the process of managing risk is to identify potential risks. 4. Common risk identification methods are: • Risk Management | 4/8/2010 • Objectives-based risk identification Organizations and project teams have objectives. industry practice and compliance. Risks are about events that. or an analysis of the 4 . the events that a source may trigger or the events that can lead to a problem can be investigated. The threats may exist with various entities. employees of a company or the weather over an airport. The scenarios may be the alternative ways to achieve an objective. Identification of risk in a selected domain of interest 2. Defining a framework for the activity and an agenda for identification. Hence. constraints. Planning the remainder of the process. or with the problem itself. Examples of risk sources are: stakeholders of a project. problem or event. When either source or problem is known. Scenario-based risk identification In scenario analysis different scenarios are created. Identification After establishing the context. customers and legislative bodies such as the government. 3.Establishing the context Establishing the context involves: 1. The identification methods are formed by templates or the development of templates for identifying source. Mitigation of risks using available technological. For example: the threat of losing money. Any event that may endanger achieving an objective partly or completely is identified as risk. when triggered. 6. 5. lightning striking a Boeing 747 during takeoff may make all people onboard immediate casualties. privacy information may be stolen by employees even within a closed network. For example: stakeholders withdrawing during a project may endanger funding of the project. risk identification can start with the source of problems. human and organizational resources. most important with shareholders. • Problem analysis Risks are related to identified threats. Developing an analysis of risks involved in the process. • Source analysis Risk sources may be internal or external to the system that is the target of risk management. Mapping out the following: o the social scope of risk management o the identity and objectives of stakeholders o the basis upon which risks will be evaluated. the threat of abuse of privacy information or the threat of accidents and casualties. The chosen method of identifying risks may depend on culture.

[5] Common-risk checking In several industries lists with known risks are available. a questionnaire is compiled.see Futures Studies for methodology used by Futurists. Any event that triggers an undesired scenario alternative is identified as risk . in the case of the value of a lost building. as follows: Composite Risk Index = Impact of Risk event x Probability of Occurrence The impact of the risk event is assessed on a scale of 0 to 5. 5 . they must then be assessed as to their potential severity of loss and to the probability of occurrence. a market or battle. Alternatively one can start with the threats and examine which resources they would affect. Therefore. One can begin with resources and consider the threats they are exposed to and the consequences of each. for example. or impossible to know for sure in the case of the probability of an unlikely event occurring. Numerous different risk formulae exist. Taxonomy-based risk identification The taxonomy in taxonomy-based risk identification is a breakdown of possible risk sources. Based on the taxonomy and knowledge of best practices. there have been several theories and attempts to quantify risks. Thus. Each risk in the list can be checked for application to a particular situation. or one can begin with the consequences and determine which combination of threats and resources would be involved to bring them about. The fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. Thus. Assessment Once risks have been identified. Asset valuation is another question that needs to be addressed.[6] Risk charting[7] This method combines the above approaches by listing resources at risk. These quantities can be either simple to measure. The answers to the questions reveal risks. Creating a matrix under these headings enables a variety of approaches. Furthermore. in the assessment process it is critical to make the best educated guesses possible in order to properly prioritize the implementation of the risk management plan.• • • interaction of forces in. risk assessment should produce such information for the management of the organization that the primary risks are easy to understand and that the risk management decisions may be prioritized. where 0 and 5 represent the minimum and maximum possible impact of an occurrence of a risk (usually in terms of financial losses). best educated opinions and available statistics are the primary sources of information. evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets. but perhaps the most widely accepted formula for risk quantification is: Risk Management | 4/8/2010 Rate of occurrence multiplied by the impact of the event equals risk The above formula can also be re-written in terms of a Composite Risk Index. Threats to those resources Modifying Factors which may increase or decrease the risk and Consequences it is wished to avoid. Nevertheless.

Further. Likewise. Medium or High. as mentioned above. Robert Courtney Jr. 1970) proposed a formula for presenting risks in financial terms. 2. The overall risk assessment is then Low. depending on the sub-range containing the calculated value of the Composite Index. both the above factors can change in magnitude depending on the adequacy of risk avoidance and prevention measures taken and due to changes in the external business environment. Transfer risks to an eternal agency (e. In business it is imperative to be able to present the findings of risk assessments in financial terms.g. and this range is usually arbitrarily divided into three sub-ranges.[8] The Courtney formula was accepted as the official risk analysis method for the US governmental agencies. 3.The probability of occurrence is likewise assessed on a scale from 0 to 5. which are: 1. For instance. Note that the probability of risk occurrence is difficult to estimate since the past data on frequencies are not readily available. all techniques to manage the risk fall into one or more of these four major categories:[9] • Avoidance (eliminate.g. Risk mitigation measures are usually formulated according to one or more of the following major risk options. withdraw from or not become involved) 6 Risk Management | 4/8/2010 . Potential risk treatments Once risks have been identified and assessed. The Composite Index thus can take values ranging from 0 through 25. by closing down a particular high-risk business area) Later research has shown that the financial benefits of risk management are less dependent on the formula used but are more dependent on the frequency and how risk assessment is performed. 9 to 16 and 17 to 25. Design a new business process with adequate built-in risk control and containment measures from the start. Hence it is absolutely necessary to periodically re-assess risks and intensify/relax mitigation measures as necessary. (IBM. an insurance company) 4. Periodically re-assess risks that are accepted in ongoing processes as a normal feature of business operations and modify mitigation measures. where 0 represents a zero probability of the risk event actually occurring while 5 represents a 100% probability of occurrence. The formula proposes calculation of ALE (annualised loss expectancy) and compares the expected loss value to the security control implementation costs (cost-benefit analysis). the three sub-ranges could be defined as 0 to 8. Avoid risks altogether (e. the impact of the risk is not easy to estimate since it is often difficult to estimate the potential financial loss in the event of risk occurrence.

• • • Reduction (optimise . This method may cause a greater loss by water damage and therefore may not be suitable. For example. calls these categories ACAT. any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. Another source. or is otherwise impractical. Early methodologies suffered from the fact that they only delivered software in the final phase of develpment. but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Accept. Hazard Prevention Hazard prevention refers to the prevention of risks in an emergency. it can optimise risk to achieve levels of residual risk that are tolerable. is too costly. Risk avoidance Includes not performing an activity that could carry risk. The first and most effective stage of hazard prevention is the elimination of hazards.mitigate) Sharing (transfer . Avoidance may seem the answer to all risks. from the US Department of Defense. Acknowledging that risks can be positive or negative. By an offshore drilling contractor effectively applying HSE Management in its organisation. sprinklers are designed to put out a fire to reduce the risk of loss by fire. in which Risk Management figures prominently in decision making and planning. but the cost may be prohibitive as a strategy. Risk Management | 4/8/2010 7 . the second stage is mitigation. By developing in iterations. optimising risks means finding a balance between negative risk and the benefit of the operation or activity. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits. An example would be not buying a property or business in order to not take on the liability that comes with it. software projects can limit effort wasted to a single iteration. Some of them may involve trade-offs that are not acceptable to the organization or person making the risk management decisions. Another would be not flying in order to not take the risk that the airplane were to be hijacked. Defense Acquisition University. If this takes too long. for Avoid. and between risk redution and effort applied. Control.[10] Modern software development methodologies reduce risk by developing and delivering software incrementally. This use of the ACAT acronym is reminiscent of another ACAT (for Acquisition Category) used in US Defense industry procurements. or Transfer. Risk reduction Risk reduction or "optimisation" involves reducing the severity of the loss or the likelihood of the loss from occurring.outsource or insure) Retention (accept and budget) Ideal use of these strategies may not be possible. Halon fire suppression systems may mitigate that risk.

Risk sharing Briefly defined as "sharing with another party the burden of loss or the benefit of gain. from a risk when it occurs. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. All risks that are not avoided or transferred are retained by default. while handling the business management itself. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much. but spreading it over the whole group involves transfer among individual members of the group. Also any amounts of potential loss (risk) over the amount insured is retained risk. 8 Risk Management | 4/8/2010 . This is different from traditional insurance.Outsourcing could be an example of risk reduction if the outsourcer can demonstrate higher capability at managing or reducing risks.[11] For example. the purchase of an insurance contract is often described as a "transfer of risk. In practice if the insurance company or contractor go bankrupt or end up in court. technically speaking. War is an example since most property and risks are not insured against war. Risk retention Involves accepting the loss. meaning that insurance may be described more accurately as a post-event compensatory mechanism. so the loss attributed by war is retained by the insured. or customer support needs to another company. from a risk. and the measures to reduce a risk. True self insurance falls in this category. or finding a physical location for a call center." The term of 'risk transfer' is often used in place of risk sharing in the mistaken belief that you can transfer a risk to a third party through insurance or outsourcing. As such in the terminology of practitioners and scholars alike. or benefit of gain. Some ways of managing risk fall into multiple categories. the original risk is likely to still revert to the first party. Risk retention pools are technically retaining the risk for the group. a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company." However. This way. The risk still lies with the policy holder namely the person who has been in the accident. For example. the company can concentrate more on business development without having to worry as much about the manufacturing process. in that no premium is exchanged between members of the group up front. the manufacturing of hard goods. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage. a company may outsource only its software development. managing the development team. the buyer of the contract generally retains legal responsibility for the losses "transferred". but instead losses are assessed to all members of the group.

Spending too much time assessing and managing unlikely risks can divert resources that could be used more profitably. an observed high risk of computer viruses could be mitigated by acquiring and implementing antivirus software. For example. and retain the rest. Mitigation of risks often means selection of security controls. the stage immediately after completion of the risk assessment phase consists of preparing a Risk Treatment Plan. which should document the decisions about how each of the identified risks should be handled. a risk concerning the image of the organization should have top management decision behind it whereas IT management would have the authority to decide on computer virus risks. which should be documented in a Statement of Applicability. reduce others. Practice. Review and evaluation of the plan Initial risk management plans will never be perfect. information risks are a good example of rapidly changing business environment. Risk Management | 4/8/2010 Limitations If risks are improperly assessed and prioritized. to evaluate the possible risk level changes in the business environment. For example. Risk analysis results and management plans should be updated periodically. There are two primary reasons for this: 1. For instance. and 2. and actual loss results will necessitate changes in the plan and contribute information to allow possible different decisions to be made in dealing with the risks being faced. According to ISO/IEC 27001. to evaluate whether the previously selected security controls are still applicable and effective. which identifies which particular control objectives and controls from the standard have been selected. The risk management plan should propose applicable and effective security controls for managing the risks. time can be wasted in dealing with risk of losses that are not likely to occur. and why. Risk mitigation needs to be approved by the appropriate level of management. Implementation Implementation follows all of the planned methods for mitigating the effect of the risks.Create a risk management plan Select appropriate controls or countermeasures to measure each risk. Unlikely events do occur but if the risk is unlikely enough to occur it may be better to simply retain the risk and deal with the result if the 9 . experience. avoid all risks that can be avoided without sacrificing the entity's goals. A good risk management plan should contain a schedule for control implementation and responsible persons for those actions. Purchase insurance policies for the risks that have been decided to be transferred to an insurer.

This is intended to cause the greatest risks to the project to be attempted first so that risk is minimized as quickly as possible. It is also important to keep in mind the distinction between risk and uncertainty. From the information above and the average cost per employee over time. The Basel II framework breaks risks into market risk (price risk).loss does in fact occur. In a financial institution. the probable increase in time associated with a risk (schedule variance due to risk. markets. This is especially true if other work is suspended until the risk management process is considered complete. interest rate risk or asset liability management. and operational risk. Qualitative risk assessment is subjective and lacks consistency. o This is slightly misleading as schedule variances with a large P and small S and vice versa are not equivalent. the probable increase in cost associated with a risk (cost variance due to risk. risk management is the technique for measuring. monitoring and controlling the financial or operational risk on a firm's balance sheet. Areas of risk management As applied to corporate finance. a risk is defined as a possible event or circumstance that can have negative influences on the enterprise in question. or cost accrual ratio. market risk. Prioritizing the risk management processes too highly could keep an organization from ever completing a project or even getting started. Rs where Rs = P * S): o Sorting on this value puts the highest risks to the schedule first. C where C = cost accrual ratio * S). or the customers of the enterprise. the resources (human and capital). estimated by multiplying employee costs per unit time by the estimated time lost (cost impact. as well as external impacts on society. In the more general case. Risk can be measured by impacts x probability. every probable risk can have a pre-formulated plan to deal with its possible consequences (to ensure contingency if the risk becomes a liability). (The risk of the RMS Titanic sinking vs. or the environment. Rc where Rc = P*C = P*CAR*S = P*S*CAR) o sorting on this value puts the highest risks to the budget first. The primary justification for a formal risk assessment process is legal and bureaucratic. Its impact can be on the very existence. Enterprise risk management In enterprise risk management. the passengers' meals being served at slightly the wrong time). See value at risk. a project manager can estimate: • • • the cost associated with the risk if it arises. enterprise risk management is normally thought of as the combination of credit risk. 10 Risk Management | 4/8/2010 . credit risk and operational risk and also specifies methods for calculating capital requirements for each of these components. the products and services.

All risks can never be fully avoided or mitigated simply because of financial and practical limitations. The purpose of the mitigation plan is to describe how this particular risk will be handled – what. industrial and finance. Further. and effort spent for the risk management.a team member other than a project manager who is responsible for foreseeing potential project problems. health. these are known as bow-tie diagrams. activities and budget. Therefore all organizations have to accept some level of residual risks. and organisations such as the IADC (International Association of Drilling Contractors) publish guidelines for HSE Case development which are based on the ISO standard. by who and how will it be done to avoid it or minimize consequences if it becomes a liability. effectiveness of mitigation activities. Optionally a risk may have an assigned person responsible for its resolution and a date by which the risk must be resolved. Each risk should have the following attributes: opening date. Hazard identification and risk assessment tools and techniques are described in the international standard ISO 17776:2000. Creating anonymous risk reporting channel. risk management includes the following activities: • • • • • • Planning how risk will be managed in the particular project. as illustrated in the equation above. Plan should include risk management tasks. Each team member should have possibility to report risk that he/she foresees in the project. when. operational risk management is regulated by the safety case regime in many countries. Assigning a risk officer . short description. Typical characteristic of risk officer is a healthy skepticism. That is to re-iterate the concern about extremal cases not being equivalent in the list immediately above. responsibilities. Risk in a project or process can be due either to Special Cause Variation or Common Cause Variation and requires appropriate treatment. diagrammatic representations of hazardous events are often expected by governmental regulators as part of risk management in safety case submissions. Maintaining live project risk database. aviation. defence. title. probability and importance. Summarizing planned and faced risks.o see concerns about schedule variance as this is a function of it. [12]’ Risk Management | 4/8/2010 Risk management and business continuity Risk management is simply a practice of systematically selecting cost effective approaches for minimising the effect of threat realization to the organization. The technique is also used by organisations and regulators in mining. Risk management techniques in petroleum and natural gas For the offshore oil and gas industry. Preparing mitigation plans for risks that are chosen to be mitigated. 11 . Risk management activities as applied to project management In project management.

“A picture paints a thousand words. cost estimates etc). Listen to the public's specific concerns. Environmental Protection Agency and several of the field's founders[14]) • • • • Accept and involve the public as a legitimate partner. Equally. to make the risk comprehensible and relatable to other risks. A main goal of risk communication is to improve collective and individual decision making. frank. Risk communication Risk communication is a complex cross-disciplinary academic field. Plan carefully and evaluate your efforts. In fact these processes are so tightly tied together that such separation seems artificial. etc. for example. the risk management process creates important inputs for the BCP (assets. the BCP process goes beyond risk management's preemptive approach and assumes that the disaster will happen at some point. The necessity to have BCP in place arises because even very unlikely events will occur if given enough time. and how controls fail.Whereas risk management tends to be preemptive. 12 . etc. aviation. Risk management also proposes applicable controls for the observed risks. Bow tie diagrams A popular solution to the quest to communicate risks and their treatments effectively is to use bow tie diagrams. its causes. Problems for risk communicators involve how to reach the intended audience. For example. welcome safety case submissions which use diagrammatic representation of risks at their core. Risk communication is somewhat related to crisis communication. These have been effectively. For this reason (amongst others) an increasing number of government regulators for major hazard facilities (MHFs). business continuity planning (BCP) was invented to deal with the consequences of realised residual risks.S. impact assessments. how to predict the audience's response to the communication.” Risk Management | 4/8/2010 Seven cardinal rules for the practice of risk communication (as first expressed by the U. the technique is used for HAZID (Hazard Identification) workshops of all types. risk management covers several areas that are vital for the BCP process. Therefore. offshore oil & gas. consequences. during the planning stage of offshore oil and gas facilities in Scotland. The bow tie diagram can be readily understood at all personnel levels. Be honest. Communication advantages of bow tie diagrams: [13]’ • • • Visual illustration of the hazard. in a public forum to model perceived risks and communicate precautions. Risk management and BCP are often mistakenly seen as rivals or overlapping practices. However. controls. and results in a high level of engagement. how to pay appropriate respect to the audience's values related to the risk. and open.

p. The Failure of Risk Management: Why It's Broken and How to Fix It.pdf. Wikipedia Risk Management Email us to receive Your Free Personal Risk-Log Now: Risk Management | 4/8/2010 Info@RemborPartners. John Wiley & Sons. ISBN 0-13-224227-3. 3. Risk management — Vocabulary.bowtiexp. International Organization for Standardization. ISBN 0859413322. Vincent T. International Organization for Standardization.htm?csnumber=43170. (April 1988).7 11. http://www.com/?mc=bet-governance&page=ss-viewresearch.asp#aboutBowTies 13. 18.htm?csnumber=44651. ^ IADC HSE Case Guidelines for MODUs 3. ^ Roehrig. Cambridge. ^ http://www. http://www. Environmental Protection Agency. ^ Common Vulnerability and Exposures list 7. http://www.• • • Coordinate and collaborate with other credible sources.2. OPA-87-020.org/iso/iso_catalogue/catalogue_tc/catalogue_detail. 15. Speak clearly and with compassion. DC: U. http://www. ^ CMU/SEI-93-TR-6 Taxonomy-based risk identification in software industry 6. 4.iso. p. UK: Woodhead-Faulkner.). Risk management — Principles and guidelines on implementation.J: Prentice Hall.org/iso/iso_catalogue/catalogue_ics/catalogue_detail_ics.com 13 . ^ a b ISO/IEC Guide 73:2009 (2009). N. Business Trends Quarterly. ^ http://www.). ^ Covello..au/bowtiexp. Douglas (2009).btquarterly. Frederick H.iso.nsai. 5. ^ Crockford. Washington.. P (2006). ^ "Committee Draft of ISO 31000 Risk management" (PDF). 2. Introduction to Risk Management and Insurance (9 ed.ie/uploads/file/N047_Committee_Draft_of_ISO_31000. ^ a b Hubbard.au/bowtiexp. ^ Disaster Recovery Journal 9. Seven Cardinal Rules of Risk Communication.asp#aboutBowTies 14. Allen. 12. ^ a b ISO/DIS 31000 (2009). An Introduction to Risk Management (2 ed. "Bet On Governance To Manage Outsourcing Risk".com. Meet the needs of the media. 8. ^ Dorfman.S. (2007). section 4. Neil (1986).bowtiexp.com. 46. 10. Englewood Cliffs. International Organization for Standardization. References 1. Mark S.

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